On The Alleged Irish Bank Deposit Flight

We can see it’s still all about the banks in Ireland. This deposit debt guarantee issue is still the critical one. The Irish Independent is talking about total nationalisation of AIB because of the ‘bank run’ hitting Ireland. And it is a bank run; AIB cannot access credit markets without a government guarantee. Either Ireland lets some banks fail or it steps in and nationalises them.

When I spoke of the bank run, I was thinking of access to credit markets for the likes of AIB or Bank of Ireland. If you recall, it was a lack of credit market access which proved fatal to Northern Rock, then to Bear Stearns and to Lehman Brothers. These were bank runs by non-depository creditors. We have seen ordinary bank runs with Northern Rock, Washington Mutual and Indy Mac, but in today’s world, it is the non-depository run that remains my worry.

Bank of Ireland, the country’s biggest lender by market value, said Nov. 12 it suffered “deposit outflows over a five- to six-week period in late August and early September.” It didn’t provide a figure. The lender lost 10 billion euros ($14 billion) in deposits in the period, Ciaran Callaghan, an analyst at Dublin-based NCB Stockbrokers, estimated today.

‘Forced to Appeal’

Allied Irish Banks Plc had similar outflows since June, the Sunday Times reported yesterday, without saying where it got the information. Catherine Burke, a spokeswoman for the Dublin-based lender, declined to comment on the report.

The five-member ISEQ Financial Index has fallen 98 percent from its peak in February 2007. Bank of Ireland and Allied Irish account for about 80 percent of the benchmark by weighting.

If “evidence of a deposit flight in Ireland” accelerates, “then the prospect of additional support to the banking system could swamp the government’s comfortable cash position,” Paul Mortimer-Lee, London-based global head of market economics at BNP Paribas SA, wrote in a note today. “Equally, if the losses on the banks were to be revised up again, then with banks in a poor position to raise private capital, the government may be forced to appeal to the European Commission for support.”

What Mortimer-Lee is getting at are the rumours of a run on Irish banks. I wouldn’t call these runs yet. But clearly this is the scenario we want to avoid. Mortimer-Lee is talking about depositors though, not just non-depository creditors. That is significant in my view. Europe’s dithering is making this a possibility, though. Ireland had one of the most extreme property bubbles in Europe. And the crash in prices has been equally extreme, with prices falling as much as 50 or 60%. There is no way the Irish banking system can take this kind of punishment. The banks are effectively insolvent – this, despite heroic efforts by the Irish government to strip away the bad assets. The Icelandic problem becomes a question then because the Irish banking system really is too big for the Irish government to credibly backstop. After I realized that the state creditor guarantees made the bank problem a sovereign debt problem, I wrote in November 2008:

It remains to be seen whether there is a sub-current of panic about the fragile Irish banking system that could lead it to Iceland’s fate. In fact, commentators like Wolfgang Munchau have argued that the single currency is a boon to the likes of Ireland because it prevents currency attacks like the one Iceland suffered, leading to its downfall.

However, a run on Irish banks is what would ultimately bring the Irish down. After all, it is the Government bank guarantee which creates the vulnerability. The Irish Government needs to make some contingency planning because an Icelandic fate is not out of the question. It need not worry about a currency run, but a bank run is still possible.

There are two ways to skin a cat.

Panic today is not what it was two years ago but the situation is spiralling out of control as it did with Greece. And I think the mix in Ireland is more toxic than in Greece because of the creditor guarantee. Sitting here and saying that the Irish have all the money in the world until mid-2011 is setting the country up for disaster in the event that creditors or even depositors pull funds.

What are the realistic scenarios here then?

The Irish get funds from the EFSF and the IMF now rather than waiting. They push ahead with austerity and rescind the bank creditor guarantees while protecting depositor guarantees. In my view, this would satisfy the EU’s desire for fiscal consolidation while making the bank backstop credible. Depositors would know their money is safe.

The ECB buys up a bunch of Irish sovereign debt to bring yields down while the Irish government denies it needs the money. They push ahead with austerity, which is voted for on Dec 7. I don’t like this scenario. The sovereign gets the ECB backstop. But rates will not come down. The Irish will still be forced into the EFSF and the arms of the IMF anyway and the prospect of bank runs could continue. Deadweight losses are likely. This is a failed strategy.

My understanding is that plans are now to use bailout money to shore up bank capital in Ireland. This is not a good idea at all – and I don’t think the Irish public would support this. Bank creditors need to be cut loose to de-couple the bank and sovereign credit issues. Moreover, the German public doesn’t want any more bailouts. So Chancellor Merkel has to talk tough. This is the reason for talking about a debt restructuring that requires bondholders who buy post-2013 take a haircut under a permanent bailout mechanism. But this also opens up the issue of haircuts for existing bondholders. I don’t see any way around this issue without talking about haircuts in a permanent version of the EFSF. Has this spooked markets? Yes. But, I say get on with it; the bailout is inevitable. Delaying is only going to make large losses in a restructuring that much more likely.

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty five years of business experience. He has also been a regular economic and financial commentator in print and on television for the past decade. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College.

Isn’t the debt-restructuring also inevitable? After the Greek tragedy, which has been gaining more steam tonight, it was made clear that one purpose to bail-out Greece was to prevent “contagion.” As it should be visible already to everyone this is not about contagion, it’s about highly leveraged countries and these countries will eventually need to tap the EFSF on. Now this “contagion” reached Ireland, which is by the way the receiving loads of praise of its preactioned austerity measures to battle against huge decifits. It didn’t work. Now Greece should battle harder? Suppose there will be countries like Portugal, Greece, Italy and Spain also funding Irish bail-out, aren’t these countries also be drowning further? EFSF may succeed to stop this after Greece, Ireland and Portugal, but looking 100+ billion euro decifits on Spain it will be pledging for the help pretty soon, too. Spain is big enough to knock Italy down (if not all the euro-countries) and after Italy falls also the France is definitely lost.

Because of this “blind guiding other blind” structure circulates from a indebted country to another the EFSF is most likely a mere bluff, or is it not?

So, no I don’t think the restructuring is inevitable if the banks are cut loose. Actually, Ireland could try flogging off the rump of one or two of its banks to a foreign bank in order to dispose of the contingent liabilities. Not that this would happen but it would certainly demonstrate that this is about the banks and not the sovereign. The reason it has become about the sovereign in Ireland is the socialized losses of an outsized financial sector.

Susijumala says 8 years ago

Yes, Ireland’s situation would have been a lot better-off without these two troublesome banks. But as EFSF cannot inject capital to these banks directly – at least not unless there will be one more rule scrapped then the question is: is there any takers for AIB? To me this Ireland’s mess is direct concequence of property bubble bursting and this won’t make any more relaxation when I take a look specific Spanish problems. I admit I don’t know how Spanish banking giants, like Banco Santander and/or BBVA are holding, except for general news they don’t see the brightest future ahead. How are they doing and if they fall can Spanish government hold them up? Or the EFSF?

Things are not too good even here in Finland, which ought to be one of the most excellent euro-nations. ECB has used policy to help these few problematic countries to get afoot. Meanwhile, people here has gone crazy leveraging themselves like there’s no tomorrow into yet-another-housing-bubble. We seriously needed higher interest rates to prevent economy overheating, but it’s too late already, and as it looks like it will only get worse during the following months. Because euro-countries are in different phases on their economies I cannot see bright future for this experiment. After we get these PI(I)GS handled we (Finns) will step on stage to steal the show.

You may have heard that the Finnish government is balking at aid to Ireland. I may write this up but it comes as the Austrians have balked at aid to Greece. This whole European experiment is coming apart. There are fewer and fewer countries in a position to provide a bailout and more and more in need of one. I think the Finns need to get their housing bubble sorted given how this is shaping up. The same is true for the Swedes.